Employers should not be able to recover VAT on pension fund management costs, says Advocate General

The opinion of the Advocate General of the Court of Justice of the European Union (CJEU) was published relating to a case involving an industrial group based in the Netherlands called PPG Holdings BV.

Darren Mellor-Clark, a VAT expert at Pinsent Masons, the law firm behind Out-law.com, said that "while this is only the AG's Opinion, it will be a disappointment to many".  He said that "the indications are that the status quo as regards pension fund vehicles is likely to remain with the management of the fund being taxable and the recovery of that tax confined to the heavily exempt activities of the fund itself".

Advocate Generals are legal advisers to the CJEU, the EU's highest court. Their opinions are not binding on the CJEU, however judges use the opinions in making their decisions and they are followed in the majority of cases.

Netherlands Law requires employers to make provision for retirement pensions for their employees and PPG Holdings set up a fund into which it paid contributions. It contracted with various service providers for the management of the fund, paying for those services, including any VAT charged.

Following a dispute with the Dutch tax authorities as to the deductibility of the VAT incurred on those services, the matter was referred to the CJEU for a ruling.

The Advocate General expressed sympathy with PPG's  argument that it was legally required to make pension fund provision for its employees, without whom it could not carry on business so that the costs of doing so was a component of the cost of the goods it supplied.

However, she thought that the legal and fiscal separation between the fund and PPG Holdings led to "the conclusion that the VAT in issue cannot be deducted". She stressed that the reason for these "impregnable firewalls" between the two entities was obvious – to protect the beneficiaries against the employer's insolvency or even the possibility of an employer's "raid" on the fund's cash.

The Advocate General also noted that the fact that PPG Holdings paid for the services was not sufficient to link them to PPG Holdings' activities. Without this link, PPG Holdings was not entitled to recover the VAT at issue. In her view, the services had been acquired for the fund's purpose of obtaining income from its investment. Those services were therefore immediately linked to the fund's activities and only indirectly to the activities of the company. That direct and immediate link with the fund's activity trumped the company's indirect link. "What counts must be the closest link, not the closest taxable link".

The Advocate General said that costs incurred in making pension contributions to staff which "relate to goods or services consumed by the employer" are linked to the economic activity of the employer. VAT may therefore be deductible when incurred on fees paid for the purpose of setting up the fund, enrolling employees or ensuring that contributions are made.

In the recent CJEU decision in Wheels Common Investment Fund, concerning a defined benefit (DB) pension fund, the appellant argued that concepts of fiscal neutrality required that the management of pension funds should be exempt from VAT. Wheels argued that the management of many collective investment schemes is exempt from VAT and pension funds are sufficiently similar to other investment collectives such that the management of them should be taxed in the same manner.

The CJEU rejected this argument and said that there were "a number of characteristics" that set DB pension schemes apart from the 'collective investment undertakings' that were able to take advantage of the VAT exception. In particular, schemes were not open to the public and members did not bear the risk arising from the management of the pension scheme funds, it said.

In her opinion in the PPG case, the Advocate General confirmed that following the Wheels decision a DB pension scheme is not "a special investment fund" for VAT purposes and that therefore the management of a pension scheme is not an exempt activity.

"For many observers the use of input tax recovery to reduce the cost burden on pension funds struggling with low investment returns was, potentially, an easier solution than the output tax liability issue raised in Wheels which was likely to have resulted in lengthy negotiations between HMRC, fund managers and fund trustees," Mellor-Clark said. "Comments in the Wheels judgement concerning defined benefit pension funds being a way for employers to meet obligations to employees had, among some, raised hopes of an input tax solution – hopes which now seem to be receding."

He adds that "aside from the final judgement in this case, businesses should still await the CJEU's decision in ATP which concerns the management of pension funds constituted as defined contribution schemes".